China’s banks’ cash holding as reserves were at a lowered level, after the central bank cut the reserve requirement ratio, or RRR, which took effect on Thursday.

The PBOC cut the RRR on Wednesday by 50 basis points, which was the first industry-wide cut in more than 2 and a half years. After the cut, big banks’ RRR was lowered to 19.5 percent. Meanwhile, the RRR was lowered by an additional 50 basis points for urban and rural commercial banks that lend to small and medium sized enterprises.

In line with investors’ expectations, analysts say the move would help in injecting more liquidity and support economic growth.

“The cut in RRR on the one side helps the steady growth of the credit sector, supports economic growth and structural adjustment. At the same time, it’s also helpful in lowering companies’ financing costs, as banks will adjust their loan pricing because they have less debt stress,” says Lian Ping, chief economist of Bank of Communication.

“The PMI contracted in the latest month, prices of bulk commodities dropped further globally, and the level of price increase was low. These gave us more space to cut the RRR and interest rates,” says Zhu Baoliang, chief economist of State Information Center.

China cuts bank reserve requirement to spur growth

Night view of skyscrapers and high-rise buildings of Jianwai Soho and Yintai Centre in CBD in Beijing, China. [Photo/IC]

China’s central bank made a system-wide cut to bank reserve requirements on Wednesday, the first time it has done so in over two years, to unleash a fresh flood of liquidity to fight off economic slowdown and looming deflation.

The announcement cuts reserve requirements – the amount of cash banks must hold back from lending – to 19.5 percent for big banks, a reduction of 50 basis points that would free up 600 billion yuan ($96 billion) or more held in reserve at Chinese banks – which could then inject 2-3 trillion yuan into the economy after accounting for the multiplying effect of loans.

“The central bank has tried to use short-term policy tools to inject more liquidity, but such tools were not enough, so it has to cut RRR,” said Wen Bin, senior economist at Minsheng Bank in Beijing, adding that signs of increasing capital outflows and a sliding domestic currency were particularly worrying.

The reduction follows a surprise cut to guidance lending rates by the People’s Bank of China (PBOC) in November, but that adjustment had negligible impact on spurring productive investment, so many had predicted the more dramatic move that the central bank has now delivered.

“Today’s announcement isn’t a surprise,” wrote Mark Williams of Capital Economics in a research note reacting to the news.

“It is consistent with the more accommodative stance being taken since the benchmark interest rate cut.”

Officials had previously said they would wait for fourth quarter data to be released before deciding on further easing measures, and that data gave little cause for comfort.

An official survey of China’s mammoth factory sector, the purchasing managers index (PMI), showed it shrank unexpectedly for the first time in nearly 2-1/2 years in January, and other indicators have also been worrying, including signs of strengthening capital outflows and a weakening in China’s service sector.

“The main reason was that the PMI was much lower than expected in January, so if there is no further policy reaction, it’s very likely that China’s Q1 GDP growth could fall below 7 percent,” said Liu Li-gang, an economist at ANZ.

Policymakers had previously signalled that they were comfortable with slowing net growth in the name of economic restructuring away from capital-intensive manufacturing toward services, but if restructuring attempts set off an economy-wide slide, Beijing would find its options increasingly constrained.

External factors contributed to the timing of the decision, economists said, such as deflationary pressures from a recent collapse in energy prices and easing moves by other foreign central banks, though domestic issues were still more important.

“The recent wave of central bank easing may have played a role, but we think the above domestic factors are the main reasons behind the RRR cut today,” wrote Zhu Haibin of J.P. Morgan, adding that the timing was not surprising, given rising systemic cash demand in the run-up to the week-long Chinese New Year holiday in mid February.

However, the weak impact of previous stimulus measures has some worried that liquidity tools are losing their effectiveness in China, given that the volume of debt required to produce a unit of GDP is steadily rising, given endemic industrial overcapacity and entrenched economic inefficiencies in the state sector.

The bank injected an estimated 644.5 billion yuan into the system through medium-term loan facilities in late 2014, without producing much in the way of stimulation, and swamping the system with money it cannot digest carries other risks.

Previous easing moves are already credited with setting off a massive leverage-fuelled rally in Chinese stock markets, which has become as much a cause for concern as celebration, as it highlights the risk that easing would simply reinflate asset bubbles in stocks, real estate and industrial housing that regulators have been trying to let the air out of for years.

China’s economic growth slowed to 7.4 percent in 2014 – the weakest in 24 years – from 7.7 percent in 2013.

Analysts polled by Reuters in January expect economic growth to sag further this year to around 7 percent.

BEIJING, Feb. 5 (Xinhua) — China’s stock markets rallied after the central bank lowered the reserve requirement ratio (RRR) on Thursday for the first time in over two years, underscoring the powerful sway of this unique monetary policy tool. Full story